Inflation has been a widely discussed topic lately. The rates are increasing, and it’s having the most significant impact on our small business community. They are grappling with rising supply costs, a shortage of workers, and decreasing profits.
Let’s demystify inflation and explore how it affects small businesses.
Grasping Inflation
Essentially, inflation refers to the increase in the prices of goods and services. Whether it’s a can of beans or a property, prices gradually rise. This change is influenced by various factors such as supply and demand, production expenses, labour shortages, expansion of money supply, and salary growth.
While it might appear contradictory, intentional inflation is beneficial to some extent. Most economists agree that maintaining a 2% annual inflation rate is ideal for achieving a balanced and growing economy. This moderate rate allows central banks to lower interest rates, boosting the economy without overburdening consumers.
The complex nature of inflation and its consequences often lead to lively debates despite the general agreement. While we cannot individually regulate the cost of living, it is crucial to comprehend how it impacts our finances.
How does it affect small businesses?
Given their limited financial reserves, small enterprises are particularly vulnerable to the inflationary pressure. With the rise in the prices of goods and services, these businesses must confront escalating costs with fewer available resources. Envision this scenario: a small enterprise vends a product for $10. Suddenly, due rising prices, production expenses increased to $12. Subsequently, the enterprise is confronted with a difficult choice—absorbing this additional cost or transferring it to customers, potentially impacting sales.
Inflation undermines the purchasing power of consumers. If your savings grow more slowly than inflation, you lose money. The interest accumulated on your savings account must exceed the inflation rate to maintain its value. With global inflation surpassing the average savings account interest rate, you may discover that your money does not stretch as far as it once did, even though the total amount remains the same.
Navigating Inflation with the Rule of 72
To approximate the impact of this erosion of purchasing power, consider the Rule of 72. While it provides only an approximate estimate and does not consider fluctuating rates over time, it is a helpful method for visualizing the potential effects on your finances if current rates continue.
To calculate the approximate time it will take for your savings to double, you can divide 72 by your annual interest rate. For instance, if you have $100 in a savings account with a 2.5% interest rate, using the Rule of 72, it would take around 28.8 years for your savings to grow to $200.
The Rule can also help you gauge how quickly inflation might affect your savings. Divide 72 by the annual rate of inflation. For example, if the rate is 6.5%, it’d take just a little over 11 years for your $100 to be worth half its value.
This demonstrates the difficulty that arises when the cost-of-living rate surpasses the interest rate that your clients earn. When prices increase, consumers are less inclined to make purchases of goods and services. If small businesses are forced to hike prices to manage inflation, it could additionally impact consumer buying ability. Hence, small businesses need to adapt to inflation to survive.
If you need to discuss the actions available for your business, feel free to contact us.